Global Economics

Sinosteel's $1.32 Billion Takeover of Midwest Succeeds

The resource-hungry Chinese company pioneers the first hostile takeover of a foreign company

Sinosteel's strategy to stay the course in its acquisition of Midwest has paid off, resulting in the first ever successful hostile takeover by a Chinese company in Australia. Sell-side adviser Morgan Stanley and buy-side adviser JPMorgan stand to benefit handsomely.

The Chinese steelmaker on Friday informed the Australian Securities Exchange that it has cornered 50.97% of Australian mining and exploration firm Midwest's outstanding shares, meaning its A$1.36 billion ($1.32 billion) takeover attempt will succeed.

Sinosteel's latest announcement marks closure to a saga which has been ongoing since the fourth quarter of 2007. The Chinese state-owned enterprise (SOE) initially came to the table as a white knight after mining and infrastructure company Murchison Metals made an unsolicited takeover offer for Midwest in October 2007. Midwest directors, advised by Morgan Stanley, felt the offer did not fully value the target and sought Sinosteel's help to rebuff it.

In December Sinosteel tabled its own offer of A$5.60 per share for control of Midwest. But Sinosteel was forced to take the proposal directly to minority shareholders in March 2008 when Midwest's directors chose not to recommend the offer to shareholders, making it the first-ever hostile bid by a Chinese company for an Australian firm. On April 29 Sinosteel improved its offer to A$6.38 per share, representing an equity value of A$1.36 billion, and gained the endorsement of the Midwest board, turning the offer friendly.

Then on May 26, Murchison unexpectedly re-surfaced with a reverse merger proposal, on which it was advised by Gresham Partners. Murchison's all-share offer implied a value of A$7.17 per share based on share prices up to May 23. Sinosteel refused to enter a bidding war and on May 28 said it would not increase its offer for Midwest.

Instead, Sinosteel raised questions about the legality of Murchison's offer, with some of its salvos making regulators sit up and take notice.

The outcome was that on July 7 Murchison withdrew its merger proposal, as uncertainties regarding its bid had put pressure on its share price, making the all-share proposal less attractive. Meanwhile, shareholders continued to tender shares to Sinosteel as they seemed to share the Chinese firm's view that, in an uncertain environment, a cash offer was a safer bet than shares.

However, Murchison does not plan to tender the 10% of Midwest it accumulated as part of its blocking strategy. The company said in an ASX filing on July 7 that it "intends to play an active role in Midwest as one of the company's biggest independent shareholders and will seek to maximise the value and strategic significance of its shareholding". This means that Sinosteel may not be able to proceed with its original plan to cross the 90% shareholding threshold and delist Midwest.

On July 10 Midwest informed the ASX that it would expand its board from six directors to nine by inducting three Sinosteel nominees. The three are: (Tony) Cheng Sijun, (Michael) Wu Hongbin and Ian McCubbin. Midwest included the new directors despite Sinosteel holding only 47.14% on that date, effectively signalling to the market that its takeover was set for success.

On the same day Midwest informed the ASX that it would issue 3 million shares worth A$19.2 million to Morgan Stanley Australia as payment for corporate advisory services, payable in the event that Sinosteel's shareholding in Midwest crosses 50.1%. Morgan Stanley has agreed to "conduct an orderly sale in the marketplace of the shares within a reasonable time period".

The A$19.2 million fee payable to Morgan Stanley is in addition to a payment already made when Murchison's original offer lapsed in February. In April, while disclosing its financial results, Midwest attributed its negative Ebitda of A$0.76 million to costs related to defending the unsolicited takeover by Murchison, including A$7.75 million paid to various advisers including Morgan Stanley.

The fee payable to JPMorgan, who guided its Chinese client to success in uncharted territory, hasn't yet been disclosed. The tactics Sinosteel employed, its legal standing and its decision not to increase its A$1.36 billion offer were all, in hindsight, spot on and the US investment bank will no doubt share a large part of the credit—and a handsome fee—for the advice it offered.

JPMorgan, and a number of other investment banks watching from the sidelines, will be hoping that a slew of China outbound M&A deals into Australia will materialise but, at the moment, this is looking less likely. Sinosteel's takeover received the blessing of Australia's Foreign Investment Review Board but it has also caused some disquiet in Australia, coming as it did close on the heels of other M&A deals in the natural resources sector.

In January, China embarked on its largest ever outbound acquisition when the Aluminum Corporation of China (Chinalco) and US aluminium producer Alcoa teamed up to buy 12% of the outstanding shares of UK-listed minerals group Rio Tinto, at an outlay of $14 billion. Rio Tinto is under siege by Australian mining firm BHP Billiton. Then, in March, Chinese oil and gas company Sinopec spent A$600 million to buy 60% of Australian oil producer AED Oil's Puffin and Talbot fields.

Most China outbound deals are being done by SOEs, a corporate structure which is alien to Australia and which raises concerns that it is actually the Chinese government that is buying Australian firms. And while Australia understands China's need to secure natural resources for its 1.3 billion strong population, questions are being asked about why the same outcome cannot be reached via long-term supply contracts between Chinese buyers and Australian companies.